Monetary conditions tightened more notably in 1Q18. Both the “price” and “quantity” indicators of credit supply pointed to more visible tightening of financial conditions in 1Q18 compared with 4Q17. According to the report, weighted average lending rate picked up by 22bp in 1Q 2018 to 5.96%. More specifically, weighted average rate of bill financing climbed by 35bp in 1Q 2018 to 5.58%, exceeding the level of 5.39% seen during the “deleveraging” episode in 2Q 2017; average interest rate of general loans also increased by 21bp to 6.01%. Meanwhile, average mortgage rate rose further by 16bp to 5.42% in 1Q18, although its rate of increase has moderated from the 25bp QoQ gain in 4Q17. In 1Q18, both the short term and long term lending rates picked up, indicating tightened financial conditions for the real economy. Meanwhile, with the administrative measures pushing towards “standardization” of banks’ credit assets since December 2017, the extent of tightening indicated by the deceleration in sequential TSF growth was more notable than the rising interest rates suggest―sequential adjusted TSF growth decelerated to 8.8% QoQ annualized in 1Q18 from 12.2% QoQ annualized in 4Q17 (after seasonal adjustment). Headline adjusted TSF growth also fell to 12.6% YoY in 1Q18 from 14.1% YoY in 4Q17. In our view, although the current level of financial cost has not yet become restrictive to growth, the rapid deceleration of overall credit supply growth, if sustained, may dampen the sequential reflationary impulse and the overall trend of moderating leverage ratio growth. It is worth noting that the administrative measures may tighten financial conditions without the corresponding increase in interest rates, as prohibiting credit issuance via certain forms of non-standardized assets (NSA), for example, raises the marginal financial cost to infinitively high levels by banning the operation entirely. Meanwhile, M2 proxy growth also decelerated visibly to 10.9% YoY in 1Q18 from12.0% YoY in 4Q17, which was partially dragged down by the Rmb700+bn YoY increase of fiscal deposits in 1Q18.

In its assessment for the global macro conditions in the 1Q 2018 MPR, the PBoC toned down the optimism regarding the near-term cyclical momentum in developed economies. Meanwhile, the central bank sees consumer price inflation higher but still largely contained both domestically and abroad. In addition, the PBoC repeatedly expressed the concerns over rising risks of trade protectionism and geopolitical tension. The central bank believes that the economic reflation has been carrying on in major economies. However, the cyclical momentum has slowed in 1Q18 in G3, part of which may be attributable to seasonal factors. On the other hand, the PBoC believes that inflationary pressure picked up, but remains under control in major economies. In regards to the emerging market economies, the central bank continues to see diverging performance. Domestically, the PBoC remains confident over the resilience of domestic demand, but has also toned down its assessment of the current cyclical momentum from “surprising on the upside” in 4Q17 to “holding up” in 1Q18. Meanwhile, the central bank observed rising CPI due to higher food prices, while PPI inflation has fallen quickly―“the forward looking (PPI) inflation may have fallen”, the central bank said, quoting one of its own surveys. On the risk front, in addition to potential risks associated with developed country monetary policy normalization and longer-term demographic concerns, the PBoC emphasized the growing concerns over rising trade protectionism and the global financial market volatility.

On the cyclical management front, monetary policy will likely maintain a neutral stance. However, the emphasis of monetary policy conduct may shift towards “stabilizing growth and fine-tuning (credit) structure”, as “deleveraging” was removed from the “Policy outlook” section this time round. Judging from PBoC’s assessment over the current growth and inflation trajectory, the central bank may focus more on “growth stabilization” compared with 4Q17. In the “policy outlook” section, the central bank listed the policy priorities as “to stabilize growth, fine-tune (economic) structure, and prevent risks”, compared with “to stabilize growth, promote deleveraging, and prevent risks” last quarter. In addition, the central bank discussed the trend of China’s leverage ratio in one of the “boxes” in MPR, concluding that the growth of China’s leverage ratio has slowed visibly due to declining leverage for both the corporate and government sectors, while household leverage ratio continued to climb. Base on the ongoing trajectory, China’s household leverage ratio growth may slow this year as well.

Over the medium-long term, the central bank may continue to fine-tune its MPA framework, stay on track with the implementation of the asset management guidelines,  promote market-oriented reforms of the interest rate and exchange rate regimes, as well as to further tighten the standards of shareholder qualifications and reflated party transaction of financial institutions. On the structural front, there are a few points worth noting from the 1Q18 MPR:

The central bank continues to fine-tune the MPR framework – the 1Q19 MPA will start to take into consideration the interbank CDs issued by financial intuitions with assets <500bn.

The PBoC will likely focus on promoting market-oriented reforms of the interest rate and exchange rate regimes, as well as removing “distortions” in the financial system that may block the monetary policy transmission. The central bank has dedicated a “box” to discussing the interest rate transmission mechanism, concluding that monetary policy transmission has improved, but remains problematic. The PBoC will likely further its effort in shifting towards a monetary policy regime that is more focused on the “price signals” – which may include removing the “blockages” in the monetary policy transmission mechanism such as the excessive growth of shadow-banking system and the entangled web of the asset management industry. Furthermore, based on the central bank’s preference over market-oriented policy conduct and the renewed emphasis over lowering real-economy funding cost, there may be more room for targeted RRR cut/MLF swap, and/or contingent RRR cut arrangement. It is worth noting that base money has shrunk YTD, partially driven by the lower effective RRR rate combined with slower expansion of the outstanding balance for PBoC relending facilities.